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Fed will revive Operation Twist in hope of stimulating recovery

September 21, 2011 | 12:13
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A divided Federal Reserve, trying to do what it can to perk up the dreary economy, announced Wednesday that it would revive a half-century-old scheme intended to make borrowing even cheaper for consumers, businesses and municipalities.

Under the plan, known as Operation Twist, the Fed would sell $400 billion in shorter-term Treasury debt in its portfolio and use the proceeds to buy an equal amount of longer-term bonds by the end of June 2012 –- a shift aimed at pulling down mortgage and other long-term rates to stimulate borrowing and spending.

"This program should put downward pressure on long-term interest rates and help make broader financial conditions more accommodative," the Fed said in a statement issued after an extended two-day meeting in Washington.

The new initiative, announced with a sobering assessment of the economy, was widely expected by investors and analysts, but few think it will do much to speed up job growth or the stalling recovery. And it flies in the face of calls by congressional Republican leaders who took the unusual step of sending a letter Monday to the Fed chairman, Ben S. Bernanke, urging him to avoid further stimulus action.

As many economists see it, the economy’s underlying problem is weak demand. Mortgage rates already are at record lows, and other borrowing costs are relatively cheap. But many corporations remain reluctant to make big investments, concerned about weakening sales and a climate of uncertainty in the global economy and fractious domestic politics. Many smaller businesses are finding it tough to get credit from wary lenders. And with home prices depressed and job growth and incomes stagnant, worried consumers are putting off major buying decisions.

"Really, it’s not a problem interest rates are too high,” said Dean Croushore, an economics professor at the University of Richmond whose own preference was that the Fed stand pat. He noted that research from Bernanke and others showed the original Operation Twist produced very modest results in the early 1960s.

Still, it’s understandable why the central bank would act, Croushore said. “They want to appear to be doing something. They don’t think it’s going to hurt; it could help a little bit, so why not?”

Clearly Bernanke doesn’t want the Fed to sit on its hands when unemployment is stuck above 9% and no new big fiscal stimulus can be expected from Congress. The Fed’s dual mandate is to maximize employment and foster stable prices. Inflation, while creeping higher earlier in the year, appears to have eased as energy and commodity prices have come down from highs, the Fed said in its statement Wednesday.

But the central bank doesn’t have much left in its arsenal. Its traditional policy tool is to nudge up and down the Fed’s benchmark short-term rate that influences many types of loans, but that’s been near zero since December 2008. On Wednesday, policymakers reaffirmed their pledge first made in August to keep the federal funds rate near zero until at least mid-2013.

Over the last three years of the recession and weak recovery, the Fed has engaged in a series of unconventional moves, essentially printing money to buy billions of government bonds and other securities to lower rates and spur growth. That’s expanded the Fed’s holdings to more than $2.8 trillion, nearly $1.7 trillion in Treasury securities, prompting accusations at home and abroad that it’s pursuing a policy to debase the dollar and that will inevitably lead to spiraling inflation.

In launching Operation Twist, the Fed opted against a more aggressive and politically riskier step of undertaking another round of outright bond purchases. Operation Twist, as it involves a shifting of existing debt, won’t add to the Fed’s balance sheet, but even this move won’t be welcome by some politicians and critics of the central bank.

"We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy," said the congressional GOP letter, dated Monday and signed by Senate Minority Leader Mitch McConnell of Kentucky, House Speaker John Boehner of Ohio, House Majority Leader Eric Cantor of Virginia and Senate Minority Whip Jon Kyl of Arizona.

GOP presidential candidates also have taken turns lobbing criticisms at the Fed, which as an independent institution tries to shield itself from political influence. Bernanke’s bigger challenge may be internal as he faces resistance to further stimulus from several committee members who are concerned that policy moves could stoke inflation. Three of the Fed’s 10 voting members, as they did in August, dissented from the policy committee’s decision issued Wednesday, indicating they did not support additional monetary easing at this time.

The Fed statement included a bleak but slightly improved assessment of the economy. The Fed excised words such as “deterioration in overall labor market conditions” and put in its place “continuing weakness” in the job market. Instead of the economy growing “considerably slower” than expected, the statement Wednesday said growth “remains slow,” with the committee continuing to expect “some pickup in the pace of recovery over coming quarters.” Last month the committee said it expected “a somewhat slower pace of recovery.”

At the same time, the latest statement issued a warning about “significant downside risks to the economic outlook, including strains in global financial markets” -– a reference to the unsettled state of affairs in Europe with its debt crisis.